• Jose Nunez

The global financial crisis started in August 2007 and lasted to 2009, which was the collapse of the subprime mortgage market (lenders with higher interest rates demand, and borrowers that can repay their loans) that led to a huge amount of losses to financial institutions in that time. The crisis led to one of the worst markets in the past 50 years. The impact it had on the economy was severe, it lead to a downward growth for U.S. companies, and an increase of uncertainty for the U.S. economy. The causes of the 2007- 2009 financial crisis were: financial innovation in mortgage markets, agency problems in the mortgage markets, and the role of asymmetric information in the credit rating process.

There weren’t as many innovations back then, so before the year 2000 only credit worthy borrowers could get mortgages unlike others that didn’t have good credit. After advances in technology and new statistical techniques, that led to better evaluations on credit risk for a new risky loan to be made. FICO was developed by the Fair Isaac Corporation, which just predicted the outcome of how likely it was for a borrower to default on their loans and not pay the loan back. By lowering the cost of transactions, newer technology was able to bundle smaller loans that were similar to mortgages into debt securities. With these factors the banks were able to give out subprime mortgages to borrowers with less than good credit scores. Also, there were agency problems in the market, the brokers who made the loans usually did not make an effort to see whether the people taking the loans could actually pay the loans back, in other words they just gave out the loans to almost complete strangers that they knew very little about and they did not have the same interest as the investors had; once the broker earned his or her commission from the loan he or she did not care about the whether the borrowers paid or did not pay the loan off. Credit rating agencies were also a factor because of their asymmetric information; they were telling clients how to structure financial instruments at the time they rated the products so different information was being passed from firms to the borrowers.

The effects it had on the U.S. economy were; housing prices went down, many subprime borrowers were finding that their mortgages were going underwater meaning that the house value was falling below the amount of the mortgage. Many homeowners just walked away from their homes giving the keys back to the lenders because the prices were going down. The default on mortgages rose tremendously, which led to many foreclosures. Value of mortgages backed securities and CDOs went down as well, and left the value of those assets to banks and financial institutions. Many of the well-known firms from had to be sold off to other larger companies for less than what they once worth and others had to file for bankruptcy. With all the things that happen in 2007-2009 in the economy, the crisis did not lead to a depression because of the actions of the Federal Reserve and government bailouts of the financial institutions but many call it a “great recession” instead. The economic recovery has been slow because people are now scared to invest their money in the markets and do not what to take on other risks, jobs are going overseas, inflation is rising, and economies of other countries are going down as well. Michael Farr said in an article from the Huffington “Corporate managers are just doing what works. Following the financial crisis, investors are not in the mood to take big risks. They would rather have the certainty that comes with higher dividend payments and increased stock buybacks”.

When the economy is about to slip i